How to properly use Pivot Points in your trading

A flaw many traders have is the habit of seeking “certainty” via indicators. It’s not uncommon to see charts with 5-7 indicators overlaid on them. However, the traders that seek certainty through indicators are usually the same traders that don’t “dig deep” into the indicator to understand how it’s built.

Today we will “dig deep” into a very useful indicator that can generate significant reference points. This indicator is useful for pinpointing entry levels, stop loss levels, and profit targets.

Pivot Points: from pit to platform
A little-known fact is that Pivot Points originated differently to other indicators. Contrary to most technical indicators, they originated within trading pits of equity and futures exchanges. This pragmatic origin is perhaps the reason why Pivot Points remain one of the most useful indicators out there.

To properly understand Pivot Points, we need to explore how they are calculated.

Note that Pivot Points can be calculated for any time horizon. Traditionally, pivots were calculated based on daily data. However, within FX this might not be the best way to employ them. But more on this later. For now, let’s start by understanding how daily Pivot Points are calculated.

The Pivot Points formula
P = Central Pivot Point = (Previous Day High + Previous Day Low + Previous Day Close)/3
R1 = Central Pivot * 2 – Previous Day Low
S1 = Central Pivot * 2 – Previous Day High
R2 = Central Pivot – S1 + R1
S2 = Central Pivot – R1 – S1
R3 = Central Pivot – S2 + R2
S3 = Central Pivot – R2 – S2

Pivots can help you sell high and buy low
If there is one principle that most traders know but tend to neglect, it’s “buy low and sell high”. However, the concepts of “high” and “low” are relative and not absolute. With Pivot Points—along with their statistical edge—we can define high and low in a very robust way.

You know that the odds can be in your favour if you are a buyer at S1. If price rallies past the central pivot and reaches R1, you might want to take some risk off the table. This is because R1 is often the high for the day.

The same rationale goes for S2 and R2. If price exceeds S1 and reaches S2, the odds can be tilted in your favour. Buying at S2 with a target at R1 is another solid way to exploit the statistical edge of Pivot Points.

Adapting Pivots to the FX market structure
One key difference in FX that throws some people off-balance is that there isn’t a centralised market open and close. In reality, three main money centres operate during a 24-hour period.

What this means is that there are actually three “market opens and closes”.

• The Asia/Pacific session: The majority of turnover in this time zone takes place in Sydney, Tokyo, Hong Kong, and Singapore. Typically, there will be exporters and regional central banks active in this session. However, the liquidity is nowhere near as deep as it is during London or New York. As such, the price action is not usually as interesting as it is during the other sessions.
  

• The London session: This is still the most important session of the day, for geographical reasons above all else. Along with London, other European financial centres are active—Frankfurt, Geneva, and Paris. That’s why large corporate flows activity takes place during this session and contributes to the deep liquidity that London benefits from
  

• The New York session: The Forex market experiences its peak in turnover as London passes the baton onto New York. However, whereas the London session tends to be trendy, New York has much more volatility and chop. Therefore, the best trading strategies to deploy change significantly. After noon in New York, liquidity starts to dry up quickly.
  

What’s next?
Pivot Points can be a versatile technical tool to help ascertain potential supports and resistances.

If nothing else, Pivot Points allow you to walk into any given session—day, week, or month—ready and prepared to react to the market’s movements. Being prepared already puts you in an advantageous position.